Hopefully someone picked up that I’m stealing the Keynes quote, “The market can remain irrational longer than you can remain solvent.” The quote has seen a recent resurgence as an explanation for why the housing bubble couldn’t be stopped: if you try to act rationally against the market’s youthful exuberance, everyone will abandon your ship before the market collapses.
Imagine that you are the manager of several portfolios in 2006. Your job is to keep and attract new clients and maximize returns better than everyone else. You know there is a housing bubble and so you want to lower your clients exposure to the bubble. But your clients are going to see you adjusting your strategy against the housing market and question you because of the great returns the market is having. Some clients may stick with you for a short time to test your prediction that this is a bubble. But if enough time passes and the bubble hasn’t popped, the client is likely to move onto to someone else who still thinks the housing market isn’t in a bubble. If all your clients do this (and they should on a long enough timeline), you lose everything. You saw this happen with people who successfully predicted the dot-com bubble but jumped ship too early–the market dismissed their predictions and they suffered dearly for it. The big question with a bubble is not whether it exists; it’s when to jump ship. When in doubt about whether to jump ship, it probably pays to risk staying through the bitter end.
Bill Henderson, law professor at Indiana, has observed a similar phenomenon occurring in the legal profession. Henderson claims the oft-cited bi-model salary distribution is caused by Biglaw’s obsession with prestige and fear of being labeled as a ‘second-rate’ firm. Accordingly, once Cravath sets its 1st year associates with a starting salary of 160k and a lockstep increase to boot, other firms are pressed to match it. The problem is that not every law firm brings in the revenue stream to justify those expenses. In order to keep the firm afloat, partners were willing to accept cuts to the profit-per-parnter (PPP), decrease the percentage of associates that become partner, decrease billable requirements, and eliminate lockstep. Of course, cutting PPP means partners in more lucrative practices are most likely to leave for better money, and you’d have to keep the slim chance of career advancement a secret, but that’s the cost of being a first-rate firm. When the economy tanked the cuts that some firms PPP would see would have become intolerable. Accordingly, associate classes were decimated, the layoffs started, and the rest is well known in our Great Recession.
I’ve editorialized Henderson’s account a bit. He makes a much more focused, nuanced argument backed with hard figures in his blog post and working paper. But his story is the most compelling item I’ve read on the legal economy. Some law firms I’m sure many firms would love to abandon the 160K lockstep model, but are afraid of losing clients who have no idea how to judge a law firm’s quality without knowing whether “the best and brightest” go there.
The big question is whether law firms will attempt to break the Cravath scale as they emerge from the economy or will they try to continue old ways. It must have become increasingly evident to many firms that they can’t stay solvent if they stay on the Cravath model. But as Henderson points out, bucking the market’s prestige-whoring ways, can have dramatic negative consequences. Unfortunately, if history is any indication, there won’t be any change until the absolute rock bottom is hit.
Undoubtedly, the larger issue is that everything law-related, and American society to an extent, is based on prestige and personal branding. Law schools spends tons of money trying to improve their USNWR rank, a critical factor (or so it’s perceived) in their school success. But rankings are a zero-sum game and the losers in the law-school ranking game end up hiking tuition without the jobs to pay them back. Scam-bloggers and legal blogs such as Above the Law maintain these law schools survive on misinformation. Once the prospective law student population wises up (thanks to their coverage of course) the bubble bursts: schools will no longer be able to afford those lavish conferences, those cushy professor salaries, large class sizes, etc. But what’s a law school who knows all of this supposed to do? Admit that they aren’t a national law school, that their median salary figures aren’t 100K+, that they are a “non-elite” law school? Would you go to that school if that’s how it marketed itself to you? Law schools are thinking probably not, and appear to ride out the bubble until destruction.
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